How Much Equity Do You Need To Refinance?

Learn about the typical equity requirements for refinancing

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Refinancing your mortgage has a number of advantages. Among them are the potential to lower your interest rate, reduce your monthly payment, change the loan terms, and switch from an adjustable-rate to a fixed-rate mortgage.

However, not everyone can qualify for mortgage refinancing. Among several requirements, you often must have at least 20% equity in your home. Learn more about the home equity requirements for refinancing your mortgage, as well as other key criteria.

Key Takeaways

  • Typically, you need home equity of at least 20% to refinance a mortgage.
  • Some, but not all, mortgage refinance loans require a credit check.
  • A home appraisal is not needed for certain refinance loans.
  • Requirements for private mortgage insurance (PMI) vary based on the type of refinance loan.

Home Equity and LTV

Home equity is the appraised value of your home subtracted by the amount you still owe on your mortgage and any other home loans, such as a home equity loan or home equity line of credit (HELOC).

Let’s say the current appraised value of your home is $325,000 and you owe $225,000 on your mortgage. That leaves you with equity of $100,000.

Lenders will use these same figures to calculate your loan-to-value ratio, or LTV. A lender will factor the LTV into determining whether to approve your application for refinancing. The LTV also will dictate whether you need to pay for private mortgage insurance (PMI). Generally, your LTV must be 80% or below to eliminate the need for PMI.

To determine your LTV, divide the remaining balance of your mortgage by the current appraised value of your home. Using our example above of a home with a balance of $225,000 and home value of $325,000, you would get an LTV of 69%, which is under the usual LTV threshold of 80%. So you would be more likely to qualify.

$225,000 / $325,000 = 0.69 or 69%

You will typically need an appraisal for a refinance. A lender usually depends on an appraisal for an estimate of how much your home is worth so they can determine how much money to lend you. In some cases, you may be able to refinance your mortgage without an appraisal by qualifying for an appraisal waiver.

An appraisal may reveal an increase in the market value of your home, which then could lower your LTV and help you score a lower interest rate.

Home Equity Requirements for Different Refinancing Options

As a rule of thumb, you’ll need home equity of at least 20% and an LTV under 80% to qualify for mortgage refinancing. Further, a lender often will want you to have a credit score of at least 620, depending on the kind of loan. However, the requirements vary based on the lender and the type of refinancing. Some government loans have lower credit score requirements.

Conventional Refinance

A conventional refinance loan (a loan that isn’t backed by a government entity) normally requires at least 20% equity and an LTV under 80%. A borrower usually must purchase PMI if the equity is less than 20%. A conventional refinance loan generally requires a minimum credit score of 620.

FHA Refinance

If you have an Federal Housing Administration (FHA) loan, you can apply for an FHA refinance loan. FHA loans typically require a credit score of at least 500. In addition, PMI must be purchased for all FHA loans.

Three types of FHA refinance loans are available:

  • FHA simple refinance: For an FHA simple refinance loan, in which you use the proceeds to pay off your existing loan, the maximum LTV is 97.75%. An appraisal is required for this kind of FHA loan.
  • FHA streamline refinance: An FHA streamline refinance loan does not have an LTV or an appraisal requirement. These loans require less paperwork. Some streamline refinance loans involve a credit check, but others do not.
  • FHA cash-out refinance: To obtain an FHA cash-out refinance loan, which allows you to withdraw equity, you must have an LTV of 85% to 95%. Also, you must get an appraisal of your home’s value.

VA Refinance

Two kinds of U.S. Department of Veterans Affairs (VA) refinance loans are available:

  • VA interest rate reduction refinance loan (IRRRL): Also known as a streamline loan, an IRRRL enables a borrower with an existing VA loan to gain a lower interest rate or switch from an adjustable-rate to fixed-rate loan. There are no LTV guidelines for an IRRRL. Also, credit checks, PMI, and appraisals are not required.
  • VA cash-out refinance loan: Current or former members of the military can qualify for a VA cash-out refinance loan, regardless of whether they currently have a VA mortgage. With this type of loan, a homeowner may be able to borrow up to 100% of their home’s value, although some lenders limit the borrowing capacity to 90%. A home appraisal is required, but PMI is not. Lenders generally look for a minimum credit score of 620.

USDA Refinance

U.S. Department of Agriculture (USDA) refinance loans let you borrow up to the remaining balance of your existing USDA mortgage. No PMI is required. While the USDA doesn’t impose any credit guidelines, a USDA lender typically will want you to have a credit score of at least 580 for most USDA loans. Cash-out refinancing isn’t available.

There are three options for USDA refinancing:

  • Streamlined: A credit check is required for a streamlined loan, and an appraisal is sometimes required.
  • Streamlined-assist: A credit check is not required, but an appraisal is sometimes required.
  • Non-streamlined: A credit check is required, as is an appraisal.

Jumbo Loan Refinance

A jumbo mortgage exceeds the loan-servicing limit set by Fannie Mae and Freddie Mac, which guarantee most mortgages in the U.S. As of May 2022, the typical limit was $647,200 for a single-family home. Interest rates for these loans are generally lower than they are for traditional loans.

The acceptable LTV for a jumbo loan refinance will vary by lender, with about 80% being typical, but with some lenders allowing for limits over 90%.

Other Ways To Tap Home Equity

Cash-out refinancing isn’t the only way to tap into your home’s equity. Here are two alternatives.

Home Equity Loan

With a home equity loan, you borrow a lump-sum amount of money based partly on the amount of equity you have in your home. You typically can borrow up to 80% of the value of your home, subtracted by the remaining balance on your mortgage, but the amount will depend on factors such as your credit score.

However, a home equity loan is a second mortgage, meaning you must pay that in addition to your regular mortgage, while a refinance loan involves just a single mortgage.

Home Equity Line of Credit (HELOC)

Similar to a credit card, a HELOC gives you a revolving line of credit. How much credit you can obtain is based partly on the amount of home equity you have. You often can borrow as much as 80% to 85% of the value of your home’s value, minus whatever you owe on your mortgage.

If you’re seeking access to cash over a longer period, like 10 years, a HELOC might be a better choice than a cash-out refinance loan, which gives you a lump sum of cash.

The Bottom Line

Generally, you need to have at least 20% equity in your home if you’re refinancing a mortgage. You also typically need a loan-to-value ratio under 80%, although some types of loans allow for higher LTV ratios.

Frequently Asked Questions (FAQs)

What happens to home equity when you refinance?

You typically maintain your home equity when you refinance your mortgage. However, the amount of equity will decline with a cash-out refinancing, home equity loan, or HELOC. Your equity increases as the value of your home increases or your principal decreases.

Can you refinance a home with negative equity?

Your home has negative equity when the amount of money you owe on your mortgage is greater than the market value of your home. Even in this situation, you may be able to take out a refinance loan, though. However, it may be tough to get a negative equity refinance loan, particularly if your credit history isn’t great.

Which is better: a cash-out refinance or a home equity loan?

Whether a cash-out refinance or a home equity loan is better depends on your situation. For instance, if you don’t want to make two loan payments at the same time, a cash-out refinance might be better. This loan replaces your original mortgage, leaving you with just one home loan. A home equity loan is a second mortgage, so you’d be making payments on two loans.

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Article Sources

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